Federal Reserve - Function, Form or What?
As you can see, money is created in our economy in two ways that are different but related. The Federal Reserve begins the process by creating "raw money" when it buys a Treasury security on the open market. The banking system can then expand this amount of money by lending it.
On the other hand, if the Federal Reserve sees the nation is threatened with inflation, it may sell some of the securities in its portfolio. Buyers pay the Fed for these securities out of their bank accounts. At this point, places like Trustworthy Bank and Reliable Savings and Loan have less money to lend. In this way, the Federal Reserve removes money from the economy since the money paid to the Fed does not go back into any sort of bank account.
A second way in which the Federal Reserve can influence the economy is by raising or lowering the discount rate, the interest rate charged financial institutions when they borrow reserves from the Fed. Although seldom used, discount rate changes can be powerful signals of the direction of monetary policy.
The Federal Reserve can also have a powerful impact on the flow of money and credit by either raising or lowering reserve requirements, the percentage of their deposits that financial institutions must keep on reserve. If the Fed lowers reserve requirements, this can lead to more money being injected into the economy since it frees up funds that were previously set aside. On the other hand, if the Fed raises reserve requirements, it reduces the amount of money that institutions are free to loan out or invest. However, the Fed is cautious about changing reserve requirements and has done so only occasionally because of the dramatic impact it can have on both financial institutions and the economy.
Two points when you look at the chart below for the past 20 years:
- you have to go back 15 years to find rates as high as they are today (except for 2001 when the Fed precipitated a recession)
- during the 15 years from 3/86 to 3/01, the rate was change 28 times; during the 5 years from 3/01 to today, the rate also has changed 28 times - three times the frequency of the previous 15 years - the Federal Reserve has completely changed its role and become an activist organization trying to control the economy.
HISTORICAL DISCOUNT RATE*
| Period in Effect | Percent Per Annum |
|---|
04/21/86 to 07/10/86 | 6.50 | 0 |
|---|---|---|
| 07/11/86 to 08/20/86 | 6 | 0 |
| 08/21/86 to 09/07/87 | 5.50 | 0 |
| 09/08/87 to 08/08/88 | 6 | 0 |
| 08/09/88 to 02/23/89 | 6.50 | 0 |
| 02/24/89 to 12/18/90 | 7 | 0 |
| 12/19/90 to 01/31/91 | 6.50 | 0 |
| 02/01/91 to 04/29/91 | 6 | 0 |
| 04/30/91 to 09/12/91 | 5.50 | 0 |
| 09/13/91 to 11/05/91 | 5 | 0 |
| 11/06/91 to 12/22/91 | 4.50 | 0 |
| 12/23/91 to 07/01/92 | 3.50 | 0 |
| 07/02/92 to 05/16/94 | 3 | 0 |
| 05/17/94 to 08/17/94 | 3.50 | 0 |
| 08/18/94 to 11/15/94 | 4 | 0 |
| 11/16/94 to 02/01/95 | 4.75 | 0 |
| 02/02/95 to 01/30/96 | 5.25 | 0 |
| 01/31/96 to 10/14/98 | 5 | 0 |
| 10/15/98 to 11/18/98 | 4.75 | 0 |
| 11/19/98 to 08/24/99 | 4.50 | 0 |
| 08/25/99 to 11/17/99 | 4.75 | 0 |
| 11/18/99 to 02/02/00 | 5 | 0 |
| 02/03/00 to 03/20/00 | 5.25 | 0 |
| 03/21/00 to 05/17/00 | 5.50 | 0 |
| 05/18/00 to 01/03/01 | 6 | 0 |
| 01/04/01 to 01/30/01 | 5.50 | 0 |
| 01/31/01 to 03/19/01 | 5 | 0 |
| 03/20/01 to 04/17/01 | 4.50 | 0 |
| 04/18/01 to 05/16/01 | 4 | 0 |
| 05/17/01 to 06/27/01 | 3.50 | 0 |
| 06/28/01 to 08/21/01 | 3.25 | 0 |
| 08/22/01 to 09/16/01 | 3 | 0 |
| 09/17/01 to 10/02/01 | 2.50 | 0 |
| 10/03/01 to 11/06/01 | 2 | 0 |
| 11/07/01 to 12/12/01 | 1.50 | 0 |
| 12/13/01 to 11/06/02 | 1.25 | 0 |
| 11/07/02 to 01/08/03 | .75 | 0 |
| 01/09/03 to 06/25/03 | 2.25 | 0 |
| 06/26/03 to 06/29/04 | 2.0 | 0 |
| 06/30/04 to 08/09/04 | 2.25 | 0 |
| 08/10/04 to 09/20/04 | 2.50 | 0 |
| 09/21/04 to 11/09/04 | 2.75 | 0 |
| 11/10/04 to 12/13/04 | 3.00 | 0 |
| 12/14/04 to 02/01/05 | 3.25 | 0 |
| 02/02/05 to 03/21/05 | 3.50 | 0 |
| 03/22/05 to 05/02/05 | 3.75 | 0 |
05/03/05 to 06/29/05 | 4.00 | 0 |
| 06/30/05 to 08/08/05 | 4.25 | 0 |
08/09/05 to 09/19/05 | 4.50 | 0 |
| 09/20/05 to 10/31/05 | 4.75 | 0 |
| 11/01/05 to 12/12/05 | 5.00 | 0 |
| 12/13/05 to 02/01/06 | 5.25 | 0 |
| 02/02/06 to 03/27/06 | 5.50 | 0 |
| 03/28/06 to 05/09/06 | 5.75 | 0 |
| 05/10/06 to present | 6.00 | 0 |
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